Daily Commentary 30/12/14

Dollar surges into year-end The dollar index hit a 2014 high yesterday despite falls in US interest rates. The continued demand for USD even in the face of lower rates shows the strength of the USD rally, which I expect to be one of the defining features of 2015.

European activity was dominated by Greece, where the failure of Parliament to elect a President yesterday automatically triggers a general election on Jan. 25th. The political turmoil sent Greek stocks down about 4% at the close, although that’s not so bad considering they were down 11.4% at one point. Greek three-year yields rose 1.6 ppt to 12.09% (they hit a low of 3.16% in early September) while German and French yields fell further to yet another record low as investors moved into safer markets. German yields are now negative out to 4 years and are lower than Japanese yields out to 5 years! There is concern that Greek banks may still rely on the ECB for funding, which could be cut off if negotiations on the country’s bailout package fail.

Yet Portuguese 3-year yields were up only 6 bps to a still-low 1.03%, while Spanish 3-year yields actually fell 10 bps to 0.6%. Both of these are lower than US three-year Treasuries at 1.11%, indicating that the markets no longer contagion from Greece’s problems to the other troubled peripheral Eurozone countries. That means the impact of the political uncertainty on EURUSD is likely to be much less than in 2012, when Greece held two elections in two months and the threat of a “Grexit” seemed quite real. Nonetheless it is likely to weaken EUR as the yield spread between Bunds and UST widens.

I think the impact of Greece’s politics on the other countries depends to a large degree on whether SYRIZA gets elected and, if it does, how big a change they can negotiate in their bailout conditions. They insist that they want to stay in the euro and have dropped their previous threat to stop repaying their debts as soon as they took office. If they are successful in renegotiating the terms of their agreement with their lenders to ameliorate the humanitarian crisis in the country, then that will embolden the alternative parties in other countries, particularly Spain.

The flight to safety plus lower oil prices sent US interest rates down as well, with longer-dated Fed funds rate expectations falling 6 bps and 10-year bond yields down 5 bps despite the Atlanta Fed raising its US Q4 GDP forecast. Inflation expectations fell back towards the multi-year low levels seen before the December FOMC meeting. Yet the lower rates did not prevent the DXY index from making a 2014 high. This to me demonstrates the demand for USD and the continued assumption that even if tightening in the US is delayed, it will still come before anything like it occurs in the Eurozone. Also, no matter how low US yields fall, at least they are still positive. You have to be pretty bullish EUR to accept negative yields in preference to positive UST yields.

USD/RUB continued to move higher, rising another 4% or so back towards 60. GDP shrank 0.5% yoy in November, according to data released yesterday, showing that the Western sanctions and the fall in oil prices have already started to hurt the economy. The continued fall in oil prices yesterday despite an attack on Libya’s largest oil port augers poorly for RUB and indeed for other commodity currencies as well. USDCAD closed at a 2014 high yesterday while AUDNZD hit what looks to me like a record low. I think the continued decline in oil and commodity-linked currencies will be another theme for 2015, at least for the beginning of the year. Later on, US oil production may decline as high-cost wells are taken offline, but so far there’s little indication of that happening yet. To add to the problems for AUD, China’s leading index fell in November to the lowest level since the depths of the international financial crisis in early 2009.

Gold fell further despite the news about Greece and lower US interest rates. One wonders just what could push it back up.

Today’s indicators: Eurozone’s M3 money supply for November is forecast to have slightly accelerated to +2.6% yoy from +2.5% yoy in October. This would push the 3-month moving average higher but still only to 2.5%. Meanwhile, credit continues to contract. It shows that the ECB has failed to transmit its monetary policy adequately to the banking system despite its efforts and adds pressure for further action.

In the US, the S & P/Case-Shiller house price index for October is forecast to have accelerated somewhat, while the Conference Board consumer confidence index for December is expected to have risen.

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